GAIL: Smooth implementation of tariff orders:: HSBC

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GAIL (GAIL.BO)
OW: Smooth implementation of tariff orders
 2QFY11 earnings in line with our estimates but moderately
higher than consensus
 Higher average tariff supports our thesis that incremental
gas volume will flow through the expanded pipelines with
higher tariff
 Reiterate Overweight and target price of INR509

2QFY11 reported profit of INR9.24bn (+30%yoy and +4%qoq) was in line with our
estimates but moderately higher than consensus. While transmission volumes were lower
owing to the unscheduled shutdown of natural gas production at Panna-Mukta-Tapti
(PMT) fields, GAIL’s transmission revenue was marginally higher as new volumes from
RIL and imported LNG were transmitted at higher tariff as per the latest tariff orders.

We believe our analysis of increasing average tariff is beginning to play out. The average
tariff grew sequentially by c10%. This gives us comfort that that the average tariff would
increase by c18% over FY10-12, in line with our hypothesis. We do expect the average tariff
to be moderately lower next quarter though, as the volumes from PMT fields are now back in
the pipelines. However, as GAIL ships incremental volume thereon which would flow through
the expanded capacity that has higher tariff, the average tariff would steadily climb.

Overhang of uncertain share of under-recovery continues to bear on valuation. The
government has been fixing up GAIL’s share of under-recovery on an ad hoc basis. We
expect upstream to bear 1/3rd of total under-recovery out of which GAIL is expected to
bear 7% largely in line with past trend and relative profitability of government-owned
upstream companies.


We reiterate our earning estimates and target price: Our estimates for FY11e and
FY12e EPS of INR30.9 and INR34.1 imply a CAGR of 17%. We value the firm on its
core business and investments. We use a forward PE multiple of 13.5x to reflect expected
growth in transmission volumes. We maintain our target price of INR509/share and
Overweight rating.


Risks and catalysts: Downside risks include any downward revision in GAIL’s tariff, a
higher-than-anticipated share in under-recovery, or an inability to obtain requisite
approvals from the regulator. Potential catalysts include updates on timely completion of
GAIL’s pipelines, new gas supply visibility, or discovery in its exploration blocks.